Navigating the Fallen Angel Crisis: Sector-Specific Strategies to Defend Portfolios in a Trade-War World

The second quarter of 2025 has marked a turning point in corporate credit markets, with deteriorating metrics, rising “fallen angels,” and escalating trade tensions pushing investors to rethink sector allocations. According to JPMorgan and PIMCO's latest analyses, $94 billion in U.S. high-grade debt was downgraded in Q2—outpacing upgrades for the first time since early 2021—while fallen angels (bonds demoted to junk status) surged to $34 billion. This shift underscores a critical reality: trade-related uncertainties and sector-specific vulnerabilities are reshaping credit risk dynamics. For investors, the path forward hinges on aggressive sector rotation, liquidity management, and a focus on defensive sectors.

The Credit Crisis Deepens: Downgrades, Fallen Angels, and Trade Wars

The data paints a stark picture. reveals a widening gap between fallen angels and “rising stars” (bonds upgraded to investment grade). In Q2 alone, fallen angels exceeded rising stars by a factor of 11-to-1, signaling systemic credit erosion. Key drivers include:

1. Trade Policy Volatility: President Trump's threat of a 35% tariff on Canadian goods has intensified sector-specific risks. Sectors like metals and mining, autos, and homebuilders—already grappling with thin profit margins—are now facing operational disruptions and rising borrowing costs.
2. Economic Uncertainty: JPMorgan's Q1 results highlighted a $973 million build in credit reserves, reflecting management's concerns over deteriorating economic conditions. The bank's embedded unemployment rate rose to 5.8%, up from 5.5% in Q4 2024, underscoring heightened caution.

The fallout is already visible in spreads. shows how rising reserves align with worsening credit metrics. Meanwhile, sectors exposed to trade wars face downward pressure on ratings.

Sector-Specific Risks: Where to Underweight

Investors must avoid sectors with structural exposure to trade disputes and weak credit fundamentals:

1. Metals & Mining:

• Risk Factors: Commodity price volatility and retaliatory tariffs have pressured margins. JPMorgan notes that metals firms with high leverage and low free cash flow are prime downgrade candidates.
• Action: Underweight speculative-grade issuers in this sector.

2. Autos & Homebuilders:

• Risk Factors: Trade barriers (e.g., tariffs on Canadian steel) and rising interest rates have crimped demand. Auto loan defaults and homebuilder inventory overhangs are rising.
• Action: Reduce exposure to cyclicals like Tesla (TSLA) and homebuilders such as Toll Brothers (TOL), which face liquidity strains.

3. Retail:

• Risk Factors: E-commerce disruption and inflation-driven consumer caution are squeezing profit margins. JPMorgan's CCB segment reported deposit outflows in Q1, signaling retail sector fragility.
• Action: Avoid retail issuers with BBB- ratings, such as Kohl's (KSS), now at heightened downgrade risk.

Defensive Sectors: Where to Overweight

To mitigate downgrade exposure, prioritize sectors insulated from trade wars and boasting strong cash flows:

1. Healthcare:

• Strengths: PIMCO highlights healthcare's resilient demand and high free cash flow. Firms like UnitedHealth (UNH) and Johnson & Johnson (JNJ) offer stable earnings and investment-grade ratings.
• Action: Overweight BBB+ issuers in pharma and medical tech.

2. Utilities:

• Strengths: Regulated cash flows and low sensitivity to trade cycles make utilities a haven. PIMCO's portfolios favor regulated power companies like NextEra Energy (NEE), which offer steady returns.
• Action: Focus on utilities with BBB+ ratings or higher.

3. Banks:

• Strengths: JPMorgan's own performance exemplifies the sector's resilience. Banks benefit from rising rates and robust fee income. Regional banks like PNC Financial (PNC) and Wells Fargo (WFC) offer yield while maintaining strong capital buffers.
• Action: Overweight large-cap banks with minimal exposure to trade-sensitive sectors.

Liquidity and Fallen Angels: The Role of ETFs

The VanEck Fallen Angel ETF (ANGL) offers a tactical tool to capitalize on dislocations. shows its outperformance in Q2 (up 1.31% vs. the broader high-yield market's 1.15%). However, individual bond liquidity remains a concern. Investors should:
- Use ANGL for broad exposure rather than picking individual fallen angels.
- Pair it with cash reserves to avoid forced selling during volatility spikes.

Investment Strategy Summary

1. Sector Rotation:
2. Underweight: Metals & Mining (e.g., NEM), Autos (TSLA), Retail (KSS).
3. Overweight: Healthcare (UNH), Utilities (NEE), Banks (JPM).
4. Credit Quality: Avoid BBB- issuers; favor BBB+ and above.
5. Liquidity Management: Allocate 10-15% to ANGL for fallen angel exposure, but retain 20-25% cash to weather volatility.

Conclusion: Prepare for a Structural Shift

The credit environment of 2025 demands active management. With trade wars exacerbating sector divergence and fallen angels reaching crisis levels, portfolios must be repositioned for defense. By tilting toward healthcare, utilities, and banks—and avoiding trade-sensitive cyclicals—investors can navigate this storm. As PIMCO's Sonali Pier notes, “The next downturn will punish those who cling to yesterday's winners.” Act now to secure tomorrow's returns.

Risks: Rising inflation, geopolitical shocks, and Fed policy shifts could alter credit dynamics. Always conduct due diligence before investing.